Can REITs Tower Again
Despite Recent Selloff?

Judging by the sharp selloff of real-estate investment trusts in recent weeks, it is clear that some investors feel the good times have come to an end for these stocks.

Yet, some analysts and investors believe that the heavy selling was too extreme and that some REITs -- particularly those in the office and retail sectors -- could stage a comeback. Indeed, just as the residential housing slump has produced some steals for home buyers, the REIT selloff may similarly yield some good deals for stock-market investors.

For a bargain hunter, a smart shopping list could include Simon Property Group Inc., Kimco Realty Corp., Public Storage Inc. and SL Green Realty Corp., which have management teams with proven track records of boosting shareholder value and which will likely continue to benefit from strong economic fundamentals.

Investors seemed to have overlooked those factors when they dumped these and other REITs, which enjoyed a seven-year stretch of outperformance until this year. REIT prices peaked Feb. 7, following the $23 billion sale of Equity Office Properties Trust to Blackstone Group. Between Feb. 7 and June 26 total returns plunged 18%, according to SNL Financial. REITs were battered again last week.

There are many reasons why investors have seemingly turned their backs on REITs, which are publicly traded real-estate companies that distribute at least 90% of their taxable earnings in dividends. Many worry that rising borrowing costs could slow the pace of REIT property acquisitions. Others simply think the trend of the past few years, when annual returns for REITs averaged 20%, is unsustainable.

According to Stifel Nicolaus analyst David Fick, more than $3 billion has flowed out of U.S. real-estate mutual funds since May 1, representing one of the strongest outflows from dedicated mutual funds in the sector's history. "Many of the investors [dumping] REITs are nontraditional real-estate investors who jumped into the market in recent years chasing higher returns but aren't long-term holders," Mr. Fick says.

But this wholesale dumping is the main reason certain blue-chip REITs offer the best bargains now. During the REIT heyday, these stocks were more widely owned by many nondedicated REIT investors. But just as these premier REITs benefited the most during the frenzy over REIT consolidation and buyouts by private-equity firms, they now are being sold off the hardest as investor sentiment has soured.

Thus, the shopping-mall company Simon Property, the biggest REIT by market value, looks like one of the best bargains. Total returns were down 16% over the quarter ended June 30, compared with a 9% drop for all equity REITs, according to SNL. It currently trades at an 18% discount to its consensus net asset value, a key measure of the underlying worth of the company's real estate, according to BMO Capital Markets. But the Indianapolis-based company is praised for its portfolio of high-end malls in cities like New York and Boston, its greater-than-average market rents and its growth potential following its recent purchase of Mills Corp., another mall REIT.

"Simon has underperformed its mall peers and the REITs overall despite what appears to be better-than-peer group and better-than-average earnings growth fundamentals," says James Kammert, a portfolio manager at Transwestern Securities Management, which has $250 million in assets and owns shares of Simon.

Analysts and investors say Public Storage and Kimco also are good deals, as total returns for these companies dropped 18% and 21%, respectively, over the past quarter. Though Public Storage, a company that provides self-storage units, benefits somewhat from people moving, investors may have overreacted to fears that the company was vulnerable to the slowdown in the housing market. Kimco, which specializes in retail space, is praised for its ability to generate fees and continue to acquire shopping centers despite high market prices for grocery-anchored centers.

Last week, analysts at FBR Capital Markets upgraded Kimco's shares to the firm's equivalent of a "buy" from "hold," with a belief that the stock was recently oversold. FBR pointed out in its research note that Kimco's shares are off nearly 30% from their February peak, compared to 20% for its peers. FBR Capital Markets doesn't own any shares of Kimco nor does it provide financial services to the company.

"It's one of the bluest of the blue chips and it's weird that it's being sold off," says Citigroup analyst Jonathan Litt, who has a hold recommendation on Kimco's stock. Citigroup has provided investment-banking services to Kimco over the past 12 months, but currently doesn't own any of the REIT's shares.

SL Green, one of the largest office landlords in New York, is a not-so-obvious pick. Investors might balk at the fact that the company trades at 24 times its 2007 consensus funds-from-operations per-share estimates, pricier than the roughly 17 times for REITs overall, according to data provided by BMO Capital Markets. FFO, as it is called, is a commonly used profitability metric for REITs that excludes gains or losses from property sales while adding back depreciation, among other adjustments.

But analysts such as Green Street Advisors' Michael Knott say SL Green trades at a significant discount to its net asset value, which is a better valuation yardstick than FFO multiples. "The company is undervalued because midtown Manhattan office-building values continue to be high, evidenced by recent record-setting prices on a per-square-foot basis, supported by a vibrant leasing market," he says. Green Street has a buy rating on the stock. Neither Mr. Knott nor his firm own any SL Green shares.

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